Cap Rate Anatomy - Retail Strip Center

[Gobears81]

I am doing an appraisal of a newer retail strip center. Good quality, strong tenants. The rents are quite high. The cap rates from the sales have been quoted from a secondary source. I contacted the seller to confirm the method of calculating and haven't heard back. My question is-for these types of properties, what is the likelihood that the cap rate calculation will not be based on annual rents/ sale price if each unit is leased triple net? Most of the brokers that I have seen market these types of properties show this type of calculation, although some of the national firms like Marcus & Millichap seem to account for reserves or minimal expenses.

 

[NachoPerito]

It depends, but most of the time for national tenants with at least 3-4 years remaining on the lease broker will say SGI = NOI

A lot of the time the tenants pay a management fee. The reserves for replacement is always so small. Most of the time they don't put in any discount for vacancy either.

You are going to have to get more information on these sales or go other places to get some sales.

 

[Michael S]

It depends on the buyer and the market but I've seen these type of properties underwritten with no vacancy and collection loss, no reserves, no expenses of any kind really. I've also seen buyers include some vacancy and collection loss (3-10% typically) and some expenses. I've seen NNN leases where management is included and some where it's excluded. I very rarely see any buyers explicitly including reserves outside of apartments. The difference between reserves and no reserves is usually pretty small, 10-20 basis points difference in the cap rate.

I just talked to one of the head acquisition people for a large private shopping center investment company this afternoon. He said their target cap rate for a grocery shadow anchored retail strip (in Albuquerque) would be about 7.00% with a cash on cash return on 8-9% based on relatively conservative CMBS financing (60% LTV, 3 years interest only, low 4% rate, 30-year amortization, 10 year call). Cash on cash is return is really what they're looking at. Hoping to get an email response with some details about how they underwrote a recent purchase of a small retail strip center that's 100% occupied. I'm curious to find out how much V&C loss they underwrote (if any).

 

[Stephen J. Vertin MAI]

I am doing a center in Highland Park, MRED MLS has a number of rates. The data is broker and owner inputted but I believe it more accurate than some survey where little is known about how data is gathered. Further, you have an actual paper trail as to where the stuff comes from. I am sure we will hear the pros and cons on this but I stand by my statement. It can be confirmed. On the north shore rates are ranging from 7 to 12 percent depending on occupancy, age, location and of course perceived risk. Since you did not say the location of your property hard to say (I am assuming it is in Illinois since your located there) but again, I find MRED has substantial data which is easily traceable. Much of it is categorized and you can see what is deducted, It stands as evidence as to whatever position you take.

It is strange I was just was going over capitalization rate data and making calls and took a short break to see what was going on in the forum. Interesting timing.

 

[PL1957]

Most multi-tenant properties will include some provision for vacancy, expenses, etc. in cap rate calculations. Secondary sources for cap rate data are pretty useless in tertiary markets. Broker interviews, listings and actual sales are far preferable to any survey out there.

 

[Gobears81]

All good responses, thanks for the input. I heard back from the seller on the properties I was looking at last night. I initially got the cap rate from those sales from Costar, and if you take the actual rents divided by the sale price, it did not equal the cap rates (though it wasn't far off), so I still don't know how they were initially calculated. But, it WAS quoted on Costar, so that might be the problem in itself.

Michael- Surprised to hear that the emphasis for this type of property is on cash on cash rates. I posted in depth in another thread or two about why I felt the emphasis should be on overall cap rates. But, if market participants (other than brokers, which often quote this to impress potential buyers) seem emphasize this metric for this type of property, then I will increase emphasis on it also.

Stephen- the property I am looking at is in Illinois, though about two hours south of Chicago. The problem in my case was that the tenant mix was a bit unique and the other sales that I was looking at were essentially the only ones with similar tenant mixes in this location. As a result, cap rates from "normal" sales of nice, new retail strip centers were considered, but they aren't taking place at the same level as this one.

Secondary sources for cap rate data are pretty useless in tertiary markets.

That is the truth. I usually quote Realty Rates, although it is more or less added discussion in a lot of cases. Robert Watts verified that the rate quotes include metro, secondary, and tertiary markets. But on the flip side, the ranges are so wide, it is pretty much guaranteed that any cap rate that you come up with will be in that range.

 

[Michael S]

Michael- Surprised to hear that the emphasis for this type of property is on cash on cash rates. I posted in depth in another thread or two about why I felt the emphasis should be on overall cap rates. But, if market participants (other than brokers, which often quote this to impress potential buyers) seem emphasize this metric for this type of property, then I will increase emphasis on it also.

That particular company, because they are relatively conservative with their financing (60% LTV typically), are able to get 3 or even 5 years of interest only. That helps push up their cash on cash return.

I haven't run the numbers but I'm curious how this arrangement would compare to a more aggressive investor who was trying to get 75% - 80% financing. They probably would have a higher interest rate and may not be able to get any interest only. I wonder how their overall cap rates would differ if both used the same NOI and the same cash on cash return. It could be that this particular investor is able to get the same cash on cash return but with a slightly lower overall capitalization rate, enabling them to beat out other investors who have to finance more.

While I usually rely on brokers for confirmation it's always nice when you can get a buyer to really open up about how they're evaluating deals as sometimes it may not be how you thought they were looking at it.